What can possibly explain the behavior of the price of oil? The Senate committee has heard testimony from a variety of sources and a variety of viewpoints ranging from accusing the regulators to be tacit participants in market manipulation to “Peak Oil”.
This same sort of back and forth happens whenever we have bubbles forming. There are always those who argue that it is simply a speculative mania, and then there are the true “believers” who bring arguments and evidence why things have changed.
To show you how difficult it is to make any sense of this, consider that two very smart and very wealthy investors find themselves on opposite sides of the argument: George Soros believes there is a bubble, while his ex-partner, Jim Rogers, feels the opposite is true.
But it isn’t difficult to see why many believe that the price of oil no longer represents a true picture of the value of this commodity; after all, it has more than doubled within the span of less than two years:
Note that the chart above is using a logarithmic axis for price and even then you can see that the slope of the rise from 2007 to present is much steeper than that between 2002 - 2006. Here’s an even more long term chart of crude, this time adjusted for inflation:
Source: St. Louis Fed (FRED database)
This chart clearly shows that the world economy is undergoing a severe “oil shock”. One that pales in comparison to ones which we’ve seen so far in either the Gulf War or the 1979 Iranian Revolution (or the 1973-4 oil embargo - not shown on chart). Which goes a long way in explaining why consumer sentiment is at multi-decade lows.
One of the defining characteristics of a mania is a parabolic chart: increasingly steep price curve within a shorter and shorter time frame. And clearly, that is what we are seeing. While there may be disagreements whether this is really a bubble, what most can not deny is that the rise we have seen so far is just unsustainable if projected into the future.
My gut feeling is that we are seeing a confluence of forces, among them, long only commodity funds, a weak dollar, negative real interest rates (which always increase commodity prices) and demand from an increasingly voracious industrial complex in China and India.
But the fact that the increase in price has come in such a short time and it has been so incredibly sharp tells me that it can not be simply explained by the usual market forces of demand and supply. Something else must be at work to drive the price of crude as high as it has done within such a short time span. But only time will reveal what exactly what that “something else” is.
If you doubt that bubbles can not form in “real assets” then you’ve probably overlooked a lot of examples from history: the Japanese real estate bubble, gold, silver, etc. And if you believe that market manipulation is impossible or the overworked imagination of conspiracy theorists, then I would remind you of the California electricity crisis in 2000.
If the price of oil here truly represents real demand and supply the potential silver lining on such a cloud is that it will not only change people’s consumption habits, it will spur on the development of better alternative energy sources. This is what I don’t understand, if you are a dyed in the wool “peak oil” believer, why invest in a dying industry? why not invest in those companies which will rise up out of the ashes and propel us forward? or do the “peak oilers” believe we are going to regress technologically?
Or consider it another way, if you were to go back in time, would you try to corner the whale oil market? or invest in Texas oil fields?